Caring about Sunk Costs: A Behavioral Solution to Holdup Problems with Small Stakes

Lorne Carmichael, W. Bentley MacLeod

Research output: Contribution to journalReview articlepeer-review

35 Scopus citations

Abstract

Economics students need to be taught that opportunity costs are important for optimal decision making but that sunk costs are not. Why should this be? Presumably these students have been making optimal decisions all their lives, and the concepts should be easy for them. We show that caring about sunk costs can help agents achieve efficient investments in a simple team production environment. Furthermore, the solution we propose is uniquely efficient if the environment is sufficiently complex. Hence, in addition to explaining contract form and ownership (Wiiliamson, 1975; Hart, 1995), studies of the holdup problem may also provide insights into observed behavior in day-to-day bilateral bargaining problems.

Original languageEnglish (US)
Pages (from-to)106-118
Number of pages13
JournalJournal of Law, Economics, and Organization
Volume19
Issue number1
DOIs
StatePublished - Apr 2003
Externally publishedYes

All Science Journal Classification (ASJC) codes

  • Economics and Econometrics
  • Organizational Behavior and Human Resource Management
  • Law

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